Decoding Asian Central Bank Monetary Policy Machinations

Posted on May 3, 2018

China, Singapore and Hong Kong’s central banks have been active in the past few weeks, altering their monetary policies in reaction to recent Federal Reserve (Fed) tightening and domestic liquid conditions – but their actions will likely have substantially different impacts on local money market rates.

The Peoples Bank of China (PBoC): Round and round

In April, the PBoC continued its hawkish strategy of shadowing Fed Rate hikes, raising both its 1-year Medium Term Lending Facility (MLF) and its 14-day reverse repo rate by 5bps to 3.30% and 2.70% respectively (Fig. 1a), increasing wholesale funding costs for commercial banks. However, later the same week, the central bank announced a distinctly dovish reserve requirement ratio (RRR) cut of 1.00% (Fig. 1b) for qualifying commercial banks (from 17% to 16% for large banks and from 15% to 14% for smaller banks).

The rate cut will release approximately CNY1.3trn, but given qualifying banks are initially required to use the funds to repay a maturing MLF of CNY900bn, the net liquidity boost will be modest and mainly impact smaller banks who do not have significant MLF loans. Nevertheless, large banks will also benefit from lower interest rate payments, as interest rates paid on reserves are significantly lower than those charged on MLF loans.

While the PBoC stressed that the RRR cut did not imply a change in its monetary policy stance, the central bank has previously avoided altering benchmark rates or the RRR due to their strong signaling effect – evident in the subsequent bond and stock market rallies. Therefore, this RRR rate should, on face value, be considered a precautionary move given recent weaker economic data, rising trade tensions and a slowdown in inflation. Meanwhile, the repo and MLF rate hikes continue to signal the central bank’s desire to forestall capital outflows and encourage continued deleveraging.

With economic growth slowing and future regulatory changes expected to tighten monetary conditions, it is likely the PBoC will continue to use targeted policy and quasi-policy rates to adjust the quantity and cost of liquidity to achieve its multiple, and sometimes conflicting, goals.

The Monetary Authority of Singapore (MAS): Down

The MAS finally exited its neutral policy stance at its semi-annual monetary policy meeting in mid-April; switching to a “measured tightening” position by “increasing slightly the slope of the S$NEER (Singapore dollar nominal effective exchange rate) policy band”.

After two years of neutral monetary policy, the market has interpreted this as implying a slope increase of 0.5%, while there was no change to the centre or width of the S$NEER policy band. The accompanying MAS commentary referenced the central banks belief that core inflation would continue to gradually trend up, while growth would remain steady.

An upward sloping S$NEER will support a stronger SGD/USD FX rate, which implies further downward pressure on SGD Swap Offer Rates (SOR) – counteracting the upward pull of Federal Reserve rate hikes. With Singapore unemployment on a downward trajectory and signs of wage price pressure, the MAS move is likely a precursor to further tightening in October. Therefore, while SOR rates should continue to increase, the SOR/Libor spread will likely widen further.

The Hong Kong Monetary Authority (HKMA): Up

In Hong Kong, mid-April saw the HKD hit the lower band of its trading range (7.85 versus the USD) for the first time in 33 years. This triggered HKMA intervention, with the central bank conducting open market operations to buy HKD and sell USD under the Linked Exchange Rate System.

While the HKMA characterized its actions as part of the normal operation of a currency peg, the growing number and size of interventions (to date, five actions totaling USD6.539bn) highlights the challenges of correcting the systemic imbalances in the local currency and interest rate markets. Fortunately, with USD440bn in FX reserves compared with the size of the aggregate balance of USD23bn, the HKMA interventions do not put the HKD/USD peg at risk.

HKD has steadily weakened over the past several months as excess liquidity from China overwhelmed the local HKD market and pushed Hibor/Libor spreads to record highs. Despite the recent HKMA measures, the HKD will likely test the lower limit again, prompting further action by the central bank – which should eventually push Hibor levels higher and narrow the gap versus US Libor, although the timing remains uncertain.

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